Post Keynesian Economics

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Cambridge Journal of Economics1996, 20, 111-135

CRITICAL SURVEYThis is the sixth of a series of Critical Survey articles. The aim of the series is to report on recentdevelopments, to provide an assessment of alternative and to suggest lines of future inquiry. It is intendedthat the articles will be accessible not only to other academic researchers but also to students and others morepractically involved in the economy. Future Su rvey articles will include Geoffrey Ingham on 'Economicsand Sociology'.

Post -Keynes ian economics : towardscoherence

Philip Arestis*

This pape r provides a comprehensive survey of post-Keynesian economics.It arguesthat post-Keynesian economicshas passed through the important initial stageofmo unting a concerted critique of mainstream economics. The focus, however, isonthe stage reflected in current post-Keynesian research which,the paper argues,isconcerned with elaboratinga distinctive coherent approach that takes precedenceover critique. Several traditions upon which post-Keynesian economics reliesareidentified. Institutionalism is proposed as an additional contributing tradition,anovel aspect ofthe paper. It is recognised, however, that more research is necessaryto complete the post-Keynesian approach.

© 1996 Academic Press Limited

Introduction 1

A growing international community of economists describe themselves as 'post-Keynesian' . For all the differences tha t exist betwee n th em , they hold stronglyto the view

Manuscript received 30 November 1992; final version received 28 July 1994.

•University of East London. The author is extremely grateful to three anonymous referees and to the

following colleagues for their helpful com men ts: Paul Auerbach, Paul Davids on, John Davis, Johan D eprez,Alistair Dow, Sheila Dow, Ciaran Driver, Murray Glickman, Francis Green, Omar Hamouda, Jan Kregel,Will Milberg, Basil Moore, P anos Pantelides, Peter Reyn olds, Malcolm Sawyer, Nin a Shapiro, Peter Skott,and Adrian Winnett.

1 There are a number of surveys of post-Keynesian economics, which differ in emphasis and coveragefrom the current essay. There is the essay by Eichner and Kregel (1975) which demonstrates the emergenceof post-Keynesian economics as a paradigm capable of challenging neoclassical economics, and Arestis(1990) which is not as comprehensive as the current essay. Harcourt (1985) and Harcourt and Hamouda(19 88) survey post-Keynesian econo mics from the point of view of contributors rather than themes as in thisessay (which is also more comprehensive). Three recent books, Arestis (1993), Carvalho (1993) and Lavoie(1993) differ not only amongst themselves but also from this essay in a substantial way. Arestis (1993)defines the Grand Neoclassical Synthesis mod el, criticises it in a major way before proceeding to analyse thebuilding blocs of a post-Keynesian model, put forward initially in Arestis (1989). Carvalho (1993)demonstrates that the notion of a monetary production economy is the unifying theme of post-Keynesianeconomics , and thereby showing that this economics provides a coherent research programme. Lavoie(1993) orchestrates his approach on a micro/macroeconomics division to show that post-Keynesianeconomics is best described as a 'post-Classical' economics.

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Post-K eynesian econ om ics: towards coherenc e 113

The first tradition stems from Marshall and is firmly rooted in theTreatise on Moneyand The General Theory. It stresses uncertainty, which is thought ofas an inherent aspectof events viewed in historical time. The future isunknowable in advance and agentscannot construct objective probability distributions, because past distributions are

non-stationary even if they exist (i.e. economic events are ome-dependent). Because ofuncertainty, expectations can be frustrated thus leading to change in economic behav-iour. An endogenous theory of expectations needs to be developed, a requirem ent whichfuture research is likely to satisfy. A further implication of uncertainty is that money isnon-neutral, which demonstrates the active role money plays in economic fluctuations.Money is associated with the law of contracts (Davidson, 1978; Minsky, 1975; Kahn,1958; Robinson, 1970), with the money-wage assuming a very important role in theanalysis, not just because it is the fundamental determinant of the price level (Robinson ,1969), but because the money-wage is the most widely utilised contract in theentrepreneurial system where money is used (Davidson, 1992). The money-wage has

also been utilised in a diagrammatic apparatus, developed by Weintraub (1958), toelucidate the relationships of aggregate supply and aggregate demand, and theirinteraction just as proposed by Keynes (1936): 'the volume of employment is given bythe point of intersection between the aggregate demand function and the aggregatesupply function' (p. 25). This interaction is the basis of distribution, output andemployment theories (Tarshis, 1939, 1947). In this tradition, in addition to economicpolicies to control aggregate demand, incomes policies are at the forefront in view of theimportance the money wage plays in determining prices.

The second tradition encapsulates the contributions of Joan Robinson and herfollowers and is essentially Kaleckian. It emphasises the role of effective demand failure,with investment demand being the driving force. Its point of departure is a distinctionbetween social classes rather than the neoclassical classless and atomistic base. Socialrelations are thus essential to the analysis and the tradition is broadly Marxist in that itadapts his reproduction scheme to tackle the realisation problem. Clearly, the kernel ofthis analysis is, as in Keynes, the idea of effective dem and. But it takes as its starting po intMarx's reproduction scheme, where the distribution of income plays a vital role. The'monetary circuit' school (Parguez, 1984; Graziani, 1989) have built up the same bodyof theory from the monetary side. It is rooted in theTreatise ofMoney and Kalecki, andit is a strong component of the endogenous money thesis. Control of aggregate demandand its composition, where the emphasis is on investment, is the fundamental econom icpolicy prescription of this approach.

Third is the institutionalist tradition of Veblen (1898, 1899) and others (see, forexample, Too l, 1988A, 1988B). It is process and evolution oriented and emphasises thedynamic and power/class structure of economic systems. These institutional andorganisational structures provide the fundamental mechanism whereby resources areallocated. In Veblen's writings (1888, 1889) the concept of 'institutions' is a wide onewhich includes and emphasises the notion of habitual behaviour of firms, households,exhibiting what would now be called 'bounded rationality1. But other institutions areimportant, such as a banking system which perm its investment to be financed, corporate

footnote 4 continued from previous pageoutpu ts as "long period centres of gravitation" . . . is therefore an obstacle to the integration of SrafEan an dKeynesian analyses, and should be abandoned' (p. 17). Moreover, the fact that the analysis of this school ofthought is institution-free, is in marked contrast to the post-Keynesian thesis that one of the most importantinstitutions is that of money and contracts.



114 P . Arestis

capitalism and trade unions, along with the interventionist state with its ability to causepolitical cycles. Economic policy proposals in this approach are designed specifically toinfluence the performance of these institutions and they focus on 'social consensus'. Thistradition strengthens two weak elements in post-Keynesian analysis. The first relates to

the contention that in Keynes (1936) expectations are treated as exogenous. Althoughthere is a rich analysis of the effects of expectations on economic behaviour, there appearsto be very little on the determinants of these expectations. An endogenous theory ofexpectations formation based on a study of political and economic institutions is required(Hodgson, 1988). The second weak element that the institutionalist approach strength-ens is the under-developed nature of Kalecki's and Keynes's microeconomic analyses,despite attempts that have been made to overcome this weakness (for example, Eichner,1973; Harcourt and Kenyon, 1976).

The post-Keynesian character of the institutionalist tradition can be highlighted byreferring to the predominant role of institutions and culture in shaping economicbehaviour: 'The system reacts to the absence of the information the market cannotprovide by creating uncertainty-reducing institutions: wage contracts, debt contracts,supply agreements, administered prices, trading agreem ents' (Kregel, 1980, p. 46).Institutions and existing conventions, however, change and can always cause a break-down in established patterns, so that crises and structural breaks ensue. Thus, routineand habit can produce tension between regularity and crisis. Keynes emphasised the'precariousness' of 'conventions' and the possibility of violent change in 'mood' and'expectation' in a cumulative way (Keynes, 1936, ch.12 ). The economic system is not a'self-balancing5 but a 'cumulatively unfolding' process. This is a view shared by bothKeynes and Veblen (and other institutionaUsts), and provides the basis of the institu-tionalist tradition widiin post-Keynesian economics. The inclusion of institutionalism in

this way is a distinguishing and novel feature of this current paper.There are differences amongst these three traditions, but at the same time there arecertain characteristics which are common to them. The emphasis on the relevance ofeconomic analysis to real economic problems and the insistence that the objective is 'tomake the world a better place for ordinary men and women, to produce a more just andequitable society' (H arcourt in Arestis and Sawyer, 1992, p. 239) are the most profound.Th us issues ofclass, power and distribution of income and wealth are at the heart of theanalysis. The economy operates subject to ahistorical process in an uncertain world,where expectations inevitably have significant effects on economic outcomes. Social,conventional, political and otherinstitutions shape economic events, and their evolutionis studied carefully.

The rest of the paper is organisedas follows: we begin with methodology and proceedto put together the main theoretical ingredients of post-Keynesian economics. A briefdiscussion of economic policy issues follows before the final section which summarisesthe argument and concludes.

Methodology in Post-Keynesian economics

Economics in the post-Keynesian mode of thought is no longer the study ofhow scarceresources arc allocated to infinite needs. It is, instead, the study ofhow actual economicsystems are able to expand their output over time by creating, producing, distributing

and using the resulting social surplus. The expansion path is uneven and likely to changethe very nature of economic systems in unprecedented ways, so that economic processes



Post-Keyn esian econ om ics: towards coherence 115

are viewed as erratic, characterised by 'circular and cumulative causation' (Myrdal,1957). Cumulative causation is a notion that operates at different levels. At the firm levelit is seen as the result of opportunities for reinvestment of profits and of dynamicincreasing returns (Kaldor, 1970). At the more aggregate level of regions, countries, and

groups of countries, the interplay of market forces is thought to increase rather thandecrease inequalities (Myrdal, 1957). There is also the more 'philosophical' point thatseveral dynamic processes always coexist in 'history5 and change occurs when theyreinforce each other in a Myrdal-type cumulative causation manner. Post-Keynesiananalysis is, therefore, concerned with an 'Economics without Equilibrium' (Kaldor,1985) and, viewed as an integral part of the social sciences, concerned with peopleorganised in groups to satisfy their needs. The behaviour of these groups in historicaltime, where the past is immutable and the future is uncertain and unknowable, is thefocus of the analysis.

The emergence of post-Keynesian economics in the way just described has been

helped by the development of thesystem or cybernetic framework which views economicprocesses as non-ergodic, that is as 'path d ependent' (Eichner, 1991). In this scheme, theeconomy is modelled as a group of dynamic subsystems. Each one of them interacts withall the other subsystems, influencing them and being influenced by them . The econom icsystem is part of several social systems, each with its own particular dynamics. As such,post-Keynesian economics adopts an open systems approach. Th is aspect is highlightedin Dow (1985, 1990), where an attempt is made to theorise about a complex reality inan essentially open and structured system, and which suggests that the study of economicphenomena may require a variety of assumptions and modes of analysis and thus anumber of equally valid approaches to understanding the same phenomenon. This'Babylonian' (Dow, 1990) or 'horses for courses' (Hamouda and Harcourt, 1988)approach demonstrates tha t knowledge is endemically incomplete so that a large categoryof things exists which are 'believed to be known, subje a to uncertainty of various degreeswhich are generally non-quantifiable' (Dow, 1990, p. 148).

Critical realism and relevancePost-Keynesian m ethodology iscritical realist, dealing with anopen and structured system:'It is structured in the sense that underlying manifest phenomena at any one level aredeeper structures, powers, mechanisms and necessary relations and so on which governthem. It is open in the sense that manifest phenomena are typically governed by variouscountervailing mechanisms simultaneously, so that the deeper structures can rarely be

directly "read o ff '' (Lawson, 1994, p. 30). The criterion for describing systems as openis the occurrence or not of constant conjunctions of actual events (Lawson, 1990). Themainstream position in economics is that constant conjunction of events is a normaloccurrence, in which case the underlying system is aclosed one. Critical realism, bycontrast, argues that in an inherently dynamic and open social world, constantconjunction of events or empirical regularities are insignificant (in the natural world theyare usually the result of active human intervention essentially via experimental controlwhich closes the system). A further difference relates to policy analysis. Whilst themainstream position in economics is to fix certain events in order to control other events,critical realism emphasises the transformation of structures in order to broaden

opportunities and realise human potential.The method of inference in critical realism is neither induction or deduction, butretroduction or abduction. This m ethod relies on moving from a set of 'stylised facts' which



116 P . A res t i s

indicates the existence of a phenomenon that necessitates 'deeper' explanation, to atheory to analyse the underlying relations, structures, conditions and mechanisms whichare responsible for the given phenomenon. It is a movement from a 'surface phenom-enon' to some 'deeper' causal factor. The task of social science is the elaboration of the

deep structures and relations which underpin social phenomena.Critical realism utilises, as its criterion of theory adequacy, the depth of explanatory

pow er of a range of empirical pheno me na rather than predictive accuracy (Lawson,1989). We cannot predict because of uncertainty and the non-ergodic character of thereal world. Economic time series approximate random walks with drift (and they are noteven always quantifiable in a precise way). This does not mean that prediction iscompletely disregarded. It simply means it is prediction of the type 'whenever event Xthen event Y' (which implies constant conjunctions of events) that is rarely feasible.Pre dictio ns of trend s in econ om ic ma gnitude s are possible within critical realism, and aremade all the rime (one may refer to the successful predictions of UK economy trends bythe Cambridge Economic Policy Group within the context of a structural model whichaccounts for qualitative and institutional features of the economy).

The form econometrics should take is, like theory,diverse and context-specific (Lawson,1983). The realist view implies that 'econometric science' is possible but it mustbe explanatory rather than predictive, because the scope for prediction is limited(Lawson, 1989). The notion that the world is characterised by 'empirical regularities' isquest ioned:

Economics isa science of thinking in terms of models joined to the art of choosing models whichare relevant to the contemporary world. It is compelled to be this, because, unlike the typicalnatural science, the material to which it is applied is, in too many respects, not homogeneousthrough time. The object of a model is to segregate the semi-permanent or relatively constantfactors from those which are transitory or fluctuating so as to develop a logical way of thinkingabout the latter, and of understanding die time consequences to which they give rise in particularcases. (Keynes, 1973, pp. 296-297)

Th eories should be relevant in that they shou ld rep resen t reality as accurately as po ssibleand should strive to explain the real world as observed empirically. Orthodox economictheory does not adhere to this basic premise, in that it is fonnalistic and makesinappropriate a priori assumptions. Post-Keynesian theory, by contrast, begins withobservation and proceeds to build upon 'realistic abstractions' rather than ' imaginarym od els ' (Rogers, 1989, pp . 189 -192 ). Th is premise has been influenced to a large extentby Kaldor's views on method (see, for example, 1985). Kaldor begins from 'stylised facts'and proceeds to theoretical explanations which account for the 'facts', 'independently ofwhether they fit into die general framework of received theory or not' (Kaldor, 1985,p . 8) . Th ey are 'stylised facts', 'beca use in the social sciences, unlike the natural sciences,it is impossible to establish facts that are precise and at the same time suggestive andintriguing in their implications, and that admit to no exception'(ibid., pp. 8-9) .

Uncertainty and historyIndividuals arc not omniscient and are able to acquire information, but their capacity todo so is limited. The complexity of information, and the limited computational abilityof the mind, considerably restrict individuals' ability to deal with a vast number of

possibilities (possibly conflicting) and their outcomes which are subject to uncertainty.Agents cannot optimise, since information is always inadequate. Consequently, under



Post-Ke ynesian econ om ics: towards coheren ce 117

such 'bounded rationality*, outcomes tend to be judged on the basis of being satisfactoryor unsatisfactory rather than measurable on a cardinal or ordinal scale. This is especiallytrue when individuals try to form conjectures about the future, which is uncertain. Thu s,'bounded rationality3 and uncertainty are two closely related ingredients of post-

Keynesian economic analysis, although 'bounded rationality' may not go far enough forpost-Keynesian economics (Davidson, 1988A). Be that as it may, the thrust of theargument is that optimisation is not the organising principle for post-Keynesianeconomics.

The essence of uncertainty in post-Keynesian economic theory is grounded in anon-ergodic, non-deterministic world understood as an open system. The future isunknown and unknowable so that economic agents' expectations can be easily frustrated.Market forces cannot deal with the unknowability and unpredictability of the future,and therefore can only disseminate incomplete, and even misleading, information.'Knowledge' of the future can be formed only indirectly from past events. Such

'knowledge' of the future can be ascertained with probability. But the conditions underwhich such a probability can be quantified are rarely met in everyday life, so that ingeneral terms probabilities of this type cannot be arrived at (Keynes, 1973). In theabsence of knowledge about the future, individuals rely on their imagination andexpectations. But they 'do not rest upon anything solid, determinable, demonstrable'(Shackle, 1973, p. 516). Thus , in the presence of uncertainty as d istinct from risk(quantifiable uncertainty), past and current events do not provide a statistical guide toknowledge about future outcomes (Hicks, 1982), so that individuals act with regard tothe extent of'potential surprise' (Shackle, 1988). Consequently, as the future unfoldsand becomes the present, continued adjustments are required to be made. This processproceeds indefinitely without equilibrium ever being achieved, let alone maintained;thus, history matters (Robinson, 1974). Economics is, therefore, more like history thanlike physics (Hicks, 1977).

Keynes, in addition to paying attention to the relationship between agents'expectations of uncertain events, emphasised individuals' expectations of each other'sbeliefs in the context of their mutual preoccupation with uncertainty (Davis, 1993; see,also, Harcourt, 1987; Carabelli, 1988; and O'Donnell, 1989). And to quote Keynes(1973): 'Knowing that our individual judgem ent is worthless, we endeavour to fall backon the judgement of the rest of the world which is perhaps better informed. Th at is, weendeavour to conform with the behaviour of the majority or the average' (p. 114).Uncertainty is not just the unknowability of the future but also the interrelationship

between belief expectations which have average expectation as their benchmark. Thisanalysis entails a dual character in terms of individuality and social relationships. That isto say, proper understanding of individuality presupposes understanding of sociality andproper understanding of social relationships means understanding of individuality.Individuals revise and change their beliefs when interacting with one another, whichproduces an identifiable system of interdependent belief expectation. T he way in whichindividual expectations are made consistent with social relationships is through theinstitution of convention. This interpretation of Keynes's philosophy inThe GeneralTheory demonstrates that uncertainty is better couched as a social relation. Whenuncertainty is portrayed in these terms, it may be considered as a different viewof 'bounded rationality'. In which case, the argument made earlier that 'boundedrationality' may not be well integrated w ith post-Keynesian economics loses some of its'weight'.



118 P . Ares tis

This leads, conveniently, to the 'weight' of the argument aspect of Keynes'sphilosophy. Keynes (1936) suggests that '[i]t would be foolish, in forming ourexpectations, to attach great weight to matters which are very uncertain' (p. 148), whereby 'very uncertain' he does not mean 'very improbable' (see his footnote 1 on p. 148,

where the reader is referredto A Treatise on Probability and to the chapter on 'The Weightof Argument'). He goes on to argue that 'It is reasonable, therefore, to be guided to aconsiderable degree by the facts about which we feel somewhat confident, even thoughthey may be less decisively relevant to the issue than other facts about which ourknowledge is vague and scanty' (ibid., p. 148). Weight, therefore, is regarded as theam oun t of relevant evidence embodied in the argument in hand , and, also, as 'the degreeof completeness of the information, or equivalently, as the balance of the relevantknowledge and the relevant ignorance on which a probability estimate is based' (Runde,1990, p . 276). W hen the weight of the argument is defined in this way there is aninteres ting direct relationship between it and confidence, that is high weight is associatedwith high confidence and low weight with low confidence. Examples of this link can befound in Keynes's discussion of investment and liquidity, so that the importance of theweight of argument is its link to investor confidence, lack of which produces 'theprecarious nature of long-run expectations' (Runde, 1990, p. 290).

The methodological aspects explored in this section imply a number of theoreticalpropositions that we now explore.

Main theoretical constructs

Post-Keynesian economics is concerned with non-equilibrium, non-market clearinganalysis and change over time. Growth and dynamics are its central parts, so that the

explanation of the erratic nature of the expansion pa th ofa capitalist economy becomesthe main focus of analysis. Unemployment is of special interest to post-Keynesianeconomic analysis as is the related issue of economic crises. The driving force of theeconomic system is seen to be effective demand, especiallyinvestment, so that capitalaccumulation along with expectations and distributional effects are at the heart of bothgrowth and business cycle theories. Investment is closely related to distribution andpricing which are linked to conflict (Marglin, 1984A). Money and finance are necessarilyintegrated with the 'real' economy from the start of the analysis. Particular attention ispaid to the institutional framework which is viewed as being of paramount importance,and to which we now turn.

InstitutionsGovernment is the institution which is vested with the power to pursue contracyclicalpolicies in an attempt to reduce the cyclical behaviour of capitalist economies. There isalso the international economy with its own institutions which interact with nationalinstitutions. There are two institutions distinctly important to our analysis: the largecorporation and the trade union.

The large corporation is the dominant institution in the production sphere of theeconomy. T here is also die non-oligopolistic firm w hich, nonemeless, does not behave asa 'perfectly competitive' firm but is more akin to what Kalecki (1971) describes as 'pureimperfect competition'. The large corporation, and more importantly the recognition of

its market power and the 'stylised fact1

that firms areprice-setters and quantity-takers, arehighlighted in post-Keynesian economic analysis. Pricing is linked to investment, with



Post-Keynesian econom ics: towards coherence 119

prices set to provide enough retained earnings which, along with external financ ing, willenable large corporations to implement their planned investment. The extent to whichplanned investment takes place once sufficient funds are forthcoming, depends onlong-term expectations regarding product markets, and on short-term expectations that

relate to the prices of financial assets. Institutional structure and industrial organisationare continuously evolving, influencing the historical development of economies in theprocess, and play a vital role in terms of the determination of the level and compositionof output, the generation of surplus and its distribution.

The prerogative to administer prices is obtained from the socio-political as much asfrom the economic power of the large corporations in product markets. In doingso, firmsare limited in their capacity to set prices at any level by a number of factors. Four factorssuggest themselves: (i) the substitution effect, that is the loss of market share tocompeting goods; (ii) the entry factor, the potential loss ofthe market share due to newentry following price changes; (iii) government intervention in the form of price controls,

special taxes, nationalisation etc.; and (iv) the presence of powerful trade unions actingas a constraint on raising prices, the rationale being that as the markup is raised beyonda certain level it could very well trigger militant action by trade unions. Unions may feelthat since the firm is achieving high profit rates they, too, deserve a higher share.

The o ther important institution is the trade union which bargains with employers overconditions of employment in general, and wages in particular. There is a conflict ofinterest here: the distribution between wages and profits is determined to a large extentby the wage demands of labour and the profit objectives of firms. Workers bargain overmoney wages, determined by a real wage target, information on immediate past inflationand expectations as to future inflation. Workers are handicapped in this process becausethe achieved real wage can only be known after the event as a function of capitalist pricingdecisions. The key point in this analysis is thatmoney wages are the result of bargainingprocesses in labour markets, while real wages are determined by labour productivity andfirm markup pricing relationships inproduct markets. An interesting implication of thisanalysis is that because a demand-for and supply-of labour framework for determiningreal wages is rejected, a lower real wage need not cause higher employment. If anything,a lower real wage, through its impact on aggregate demand, is expected to decreaseemployment.

Monetary institutions as they operate and evolve reflect fundamental characteristics ofmoney, and constitute an essential part of post-Keynesian m onetary and financial heory.

Money and financeThe most important characteristic of post-Keynesian monetary and financial theory isthat money is a link between the past and the present and also between the present andthe future (Keynes, 1936, p. 294). The past is given and cannot change, whilst the futureis uncertain. Uncertainty, which is inherent in historical time, is seen as the necessary andsufficient condition for the existence of money, so that money is fully integrated into theanalysis. Institutions are as important, since in modern economies moneyis ightly inkedto the institution of banking (Minsky, 1986). Consequently, money can only be studiedin an historical and institutional context. A crucial institutional aspect of money is thatit is an endogenous and demand-determined magnitude. Money is not exogenous asin orthodox analysis, but the result of credit flows in a dynamic monetised produc-tion economy (Eichner and Kregel, 1975; Parguez, 1984; Moore, 1988; Graziani,1989), where the leading role is essentially played by entrepreneurs and their 'animal



120 P. Arestis

spirits.' Entrepreneurs must predict the pattern of effective demand and infer from thisthe cash outlays required to pay for the factors of production to be employed. Theymust also estimate the outlays required to finance investment. Once this is done, theirloan requirements from the banks can be ascertained and their demand for credit

formulated.The Central Bank administers the level of the discount rate and commercial banks

administer their lending and deposit rates (given banks' uncertain assessment ofrisk andvalue of collateral). At this level and structure of interest rates, banks stand ready toprovide whatever loans the entrepreneurs' requirements for credit entail, so long as theyare within their prearranged credit limits. An increase in the demand for credit leads toan increase in its supply, and thus to an increase in the existing money stock, withoutnecessitating a change in interest rates, unless the Central Bank varies its administeredrate, changes of which influence directly changes in administered interest rates via amarkup process. It is the rate of interest that is the control instrument of monetarypolicy.

In open economies interest rate changes can also be the result of events emanatingfrom abroad (witness, for exam ple, the position of the UK in the European Union in thisregard). The level of short-term rates as administered by the domestic monetaryauthorities relative to that set by foreign monetary authorities affects the exchange rate.This link brings to the fore theforeign sector aspects of the economic system. Theseaspects are incorporated into the analysis through the current and capital accounts of thebalance of payments, where the exchange rate influences and is influenced by the stateof both accounts.1 The importance of the balance of payments as a constraint to growthhas been discussed extensively (see, for example, Thirlwall, 1980). The argument is thatcountries with high income elasticity of demand for imports, and low income elasticity

of demand for exports, experience balance of payment difficulties which restrictgovernments in their attempt to expand aggregate demand.There is the argument, however, that the supply of money may only be demand-

determined up to a point (Dow and Dow, 1989; Wray, 1990). This view combinesliquidity preference theory and endogenous money supply theory to argue that, sincecommercial banks have a varied and complex set of portfolio choices to make, they havetheir own liquidity preference. They may, thus, not be willing to lend an infinite amounton given terms. Changes in banks' liquidity preference influence the amount of creditavailable and thus the m oney stock. Since banks' risk assessment is based on incompleteknowledge, their liquidity preference changes as their perceptions of risk alter (whenexpectations are not fulfilled and when confidence changes owing to new inform ation).Also, periodic bank runs on liquidity which generate debt deflation imply that moneycould not be created unless liquidity premia are raised to induce expansion of balancesheets. Given the administered interest rate, commercial banks ration credit if theirliquidity preference dictates it.

In this process there is an inherent tendency for investors to increase the level of theirindebtedness, and in moments of optimism they do so rapidly. If lending institutionsshare this optimism and if their liquidity preference does not change, demand from theprivate sector would be accommodated. The ensuing vulnerability of both firms and

1 A novel feature of the imports element of the current account is the proposition that the marginalpropensities to import out of workers' income and out of the income of capitalists differ. Arestis and Driver(1987) explore this proposition along with empirical backing in the case of the UK. This is an extension ofthe idea of distinguishing income classes in consumption.



Post-K eyneslan econ om ics: towards coheren ce 121

banks is heightened as a result, so that financial fragility increases, which can causedebt-deflation if it is accompanied by changes in expectations and consequent attemptsto re-establish liquidity positions. This is Minsky's (1982, 1986) 'financial instabilityhypothesis', which emphasises the interaction between financial and real variables anddemonstrates that crises are essentially caused by risky financial practices during periodsoffinancialfragility.

Th e 'financial instability hypothesis' may be related to the 'stages of banking' approach(Chick, 1986, 1989), viewed as a 'logical' reconstruction of the developments of bankingsystems. The capacity of banks to create credit depends crucially on their stage ofevolution. This capacity is enhanced with the degree of banking development whichenables banks to become more independen t of reserve requirements, thereby making thesupply of credit, and of money, more responsive to demand. As the banking systemdevelops, the nature and degree of credit and money endogeneity change. Chick(1989) has suggested that a new stage has surfaced recently, with its main character-

istic being securitisation, whereby commercial banks design loans that are marketable,so that the maturity mismatch between commercial bank assets and liabilities dimin-ishes. This process of securitisation enables commercial banks to avoid 'capitaladequacy' ratios, thus enhancing the endogeneity of money. As securitisation, takescredit off bank balance sheets altogether, however, it only increases the endogeneity ofmoney if money is defined as being broader than bank deposits. The globalisation offinancial markets has similar implications w ith regard to the endogeneity of money.These financial developments strengthen the link with Minsky's 'financial instabilityhypothesis' in that the ability of financial institutions to create more debt enhances thedegree of fragility of the system and thus the vulnerability of both banks and firms.Most important, though, the 'stages of banking' approach puts the two views ofmoney, the 'exogenous money" view and the 'endogenous credit5 view, in their properhistorical perspective.

Production, prices and pricingMoney and production are organically linked in post-Keynesian economics. Pricing, theprocess ofprice formation, and the determination of steady-state prices which gives riseto a theory of prices, are not the result of a market-clearing process, as in orthodoxeconomic analysis, but are determined by factors and conditions that prevail in theproduction sphere. They are also directly linked to investment and distribution. Theselinks are amplified and elucidated next.

The post-Keynesian production model is an input-output model that is characterisedby the assumption that inputs can be used only in fixed proportions with each other inproduction.1 Leontief (1951) formulated it in both theoretical and empirical terms , andit can be related to Sraffa's (1960) fixed-coefficien t model and Pasine tti's (1981)input-output model, both of which highlight issues of distribution and growth. TheLeontief model consists of n industries (with n being greater than two), each producingintermediate and/or final output. This model can be solved for the vector of output (q)to give: q = ( I -A) ~ * x, where I is an n x n unit matrix, A is the matrix of the fixedtechnical coefficients, so that(I — A) ~ ' is the Leontief inverse and x is the vector of finaloutput. This equation determines the output of each ofthe industries that comprise the

1 The post-Keynesian production m odel belongs to the more general category o f fixed-coefficient' m odelsof production which have their roots in the tableau economique of Francois Quesnay. Under thesecircumstances, the convexity property of the neoclassical production set and thus rising marginal costs, areassumptions which are not necessary for the purposes of post-Keynesian economic analysis.



122 P . A res tis

production system. The Leontief model can also be solved for the vector ofprices (p):p = ( I - A) ~ ' V, where V is the matrix of input values, defined as V= tu l+ «, wherew isa scalar (the wage rate),1 and n are vectors of labour inputs and residual income earnedby each industry, both per unit of output produced. The P-equation provides the

solution for the set ofrelative prices that must be charged ifthe production system is tocover all the costs of production. It specifies a value condition that must hold in the longrun; it does not represent the set of prices that will actually prevail. To establish the latterit is necessary to supplement the long-period determination of prices with a short-periodmodel of pricing behaviour, as explained below.'

The Leontief model has been extended in a num ber of ways. There is Sraffa's (1960)reformulation which produces the important proposition that distribution of incomecannot be treated independently of prices.2 To move from the Leontief model to theSraffian model we first note that in the latter the residual income vector(n) is assumedunder a uniform rate of profit(WQ).acrossindustries, which clearly identifies its roots inthe classical tradition. So that now in the expression:V = O J 1 + W, we should have:V=tul+«opA. Substituting for V in the P-equation we arrive at: p=(I+»ro)pA+u>l,which is the standard Sraffian P-equation. It contains a very important feature in thatwages and profits are now competing claims on the economic surplus, although it isambiguous abou t the scale of production and the level of effective dem and, given mat theexpression is scale-free. The wage rate and the profit rate depend heavily on the strugglebetween workers and capitalists. Robinson (1980) summed it all up as follows: 'Sraffa setup a multi-comm odity input-ou tput system and showed that, corresponding to any shareof wages, there is a particular pattern of normal prices that yields a particular uniformrate of profit on capital valued at those prices' (p. 81).

The generation of the surplus by each industry and its division between workers and

capitalists are explained within the model. The latter depends on noneconomic factorswhich determine the relative bargaining power of the two groups. Changes in thedistribution betweenu> and n0 lead to changes in the value added by each industry (V),and through it to changes in relative prices because p depends on V. Consequently,prices in the Sraffian model are closely related to the distribution of income via the profitrate relative to the wage rate. One important assumption in the analysis is that the rateof profit refers to the working capital requirements of each industry in advance ofproduction, and, thus, at the expense of wages. In the second part of his book, Sraffa(1960) accounts for fixed capital as well. He suggests that fixed capital should be viewedas an input that gives rise to one output which is the good or service produced by the

1 It is important to Hi»ringimh at this juncture between the terms 'run/term' and 'period', which areneither synonymous nor is there a direct correspondence between them. 'Period' refers to states of'equilibrium' while 'run' is about 'processes of motion'. Short-period and long-period 'equilibrium' can bedefined independently of short run and long run. Short run and long run refer to movements towards'equilibrium' which m ust take place in historical time. Ro binson ( 19 56 ) puts th e difference in the followingway: 'Long-period changes are going on in short-period situations. Changes in output, employment andprices, taking place with a given stock of capital, are short-period changes; while changes in the stock ofcapital, the labour force and the techniqu es of production are long-term change s . . . A given short-periodsituation contains within itself a tendency to long-period change' (p. 180). In this view, long-period analysisis concern ed with the exam ination of a sequence of short periods. Carvalho (19 84/8 5, 1990) gives a numb erof exam ples to clarify this difference, and in Carvalho (19 90 , p. 28 0, fii.l) Harcourr's insistence on theimportance o f the distinction betwee n 'run' and 'period' is acknowledged .

2 T he Sraffian m ode l is concern ed with an economic system which is merely reproducing itself over time,and does not account for changes in the technique and expansion of the economic surplus. These twoaspects are dealt with by Von Ne um ann (19 45 -46 ). See Schefold for similarities and differences between thetwo mo dels, and Eichner (19 91) for a synthesis of the Sraffa and Von N eum ann m odels.



Post-Keynesian econo mics: towards coherence 123

fixed capital. It also provides another output, this being the fixed capital itself whichbecomes a capital input of a different type once it has produced one type of good orservice.

Another extension of Leon tiefs model is Pasinetti's (1981) construction ofa vertically

integrated version with labour as the only input. Technical progress is included in themodel, thus making it possible to examine its impact on productivity, defined as outputper worker over time. Leontiefet al. (1978) extended the model still further to accountfor natural resources , in addition to labour, as the inputs to produc tion on a global scale.They are thus able to examine the terms of trade between primary producers andindustrial countries.

These m odels produce a price vector, or set of relative prices, which can be interpretedas a set of cost-of-production prices. This price solution requires that the wage rate andthe labour coefficients for each industrybe specified, and depends on the residual incomeor the markup set in each industry. These are the prices which must prevail in the longperiod if the costs of production are to be covered. This configuration of prices whichsatisfies some economy-level, steady-state conditions, generates a theory of priceswithout being concerned with the process of price formation.

Concern with the process of price formation, or how prices are determined at the levelof firm or industry , gives rise to consideration ofthe mechanism for the setting of prices.One pricing theory is that the markup is determined by the financial needs of firmsrelative to the monopoly power they can exercise (Eichner, 1973, 1976; Wood, 1975;Harcourt and Kenyon, 1976).* This and other post-Keynesian pricing theories (Steindl,1952, 1979; Asimakopulos, 1975; Cowling and W aterson, 1976), are based on Kalecki(1954) in that they recognise hat all markets are not perfectly competitive and that thereis a distinction between sectors where price changes are 'cost-determined' and where

they are 'demand-determined'. Furthermore, they all postulate that prices of finishedgoods are determined by a markup on some measure of unit costs. The markup isdetermined by the need to finance investment (Eichner, 1976),2 so that pricing may belinked to the theory ofinvestmentand class conflict.

Investment, distribution andclass struggleInvestment in the post-Keynesian tradition is determined by,inter alia, expectedprofitability. But it is recognised hat whilst it isexpected profitability that induces capitalaccumulation, realised investment creates the profitability which makes investmentpossible, partly through internally generated funds (Robinson, 1962). Expected profit-ability is essentially influenced by two sets of factors. The expected rate of return oninvestment, or in other words the marginal efficiency of investment (MEI), which givesrise to an investment relationship that is sensitive to fluc tuations in interest rates and tothe expected growth of sales.

These propositions are based on both Keynes's (1936) and Kalecki's (1971) theoriesof investment. It can be argued that Kalecki's theory is an improvement over Keynes'sMEI theory in that Kalecki identifies the factors which cause the MEI relationship toshift. Kalecki's basic prem ise is that investment depends on the level of profits relative to

1 Whilst both Eichner's and Wood's contributions are 'Golden Age', logical time, type of models, theanalysis of Harcourt and Kenyon (1976) is conducted in historical time. In this sense, the Harcourt andKenyon (1976) model is much more within the spirit of post-Keynesian analysis in general, and pricing inparticular.

1 There are important differences amongst post-Keynesians on pricing (see Sawyer, 1990, for an extensivediscussion of these differences).



124 P. Ar esd s

capital as well as on the rate of interest. This is not a very different proposition fromKeynes's, once we recognise that the rate of return in Kalecki is calculated at theaggregate level rather than at Keynes's firm level, and that the size of capital stock isrelevant to investment decisions in a way that it is not in Keynes's model (see, however,Davidson, 1978). There is, nonetheless, an important difference in method betweenKalecki's and Keynes's treatment of investment. Keynes assumes as given the state ofexpectations of returns in determining the level of investment (although when Keynesmoves to the chapter on cycles this assumption is no longer maintained; see Kregel,1976). By contras t, in Kalecki's investment analysis the state of expectations is affectedby changes in investment. W hen the state of expectations is affected in this way, it causeschanges in the price of investment goods and interest rates, so diat a new level ofinvestment ensues (see Targetti and Kinda-Hass, 1982; also, Robinson, 1962; andAsimakopulos, 1977).

There are now two differentways in which the level of profits affects investment. First,profits are seen as a source of funds that would enable investment to be undertaken.

Obviously, then, retained profits along with funds set aside for depreciation purposesassume a very significant role in the investment decision process. The larger the retainedprofits and depreciation allowances, the greater the ability of firms to proceed with thecapital expenditure programmes. External sources of funds are also viewed as beingimportant, but because of the principle of increasing risk (Kalecki, 1954) the level ofinvestment is still, to an ex tent, constrained by available internal funds. Both Kalecki andKeynes put a lot of emphasis on the importance of finance in permitting the rate ofinvestment to take place.'

The second way in which profits affect investment is in terms of whether firms'expectations about the future are likely to materialise: rising profits signal healthy futureeconomic conditions, which are likely to make firms adopt a more optimistic stance andthus proceed with their investmentplans. Falling profits indicate deteriorating economicconditions to firms, so that they become pessimistic and are more reluctant to go aheadwith planned investment. Therefore, changes in the level of profits are the main cause ofshifts in the MEL

The calculation of the MEI depends crucially on the values assigned to the stream ofexpected net returns of investment. These values, however, are highly uncertain. Keynes(1936) argues that little can be saida priori about the state of confidence.Convention ishighlighted in The General Theory, where it is viewed as relying on the assumption that the'existing state of affairs' does not change (see, also, Kregel, 1976, 1987). Investment,then, is the result of the 'animal spirits' of entrepreneurs, what Keynes labelled as profit

expectations of the business comm unity (Keynes, 1936, pp. 161-162), a purely subjec-tive concept which is not susceptible to probabilistic manipulation. The pervasive natureof expectations under uncertainty which influences entrepreneurs' 'animal spirits' is ofvital importance in the capital accumulation process, so much so that the volatility ofexpectations under uncertainty is thought to lead potentially to structural breaks andcrises. Uncertainty leads to volatility in the sense that the stability, which emerges from

1 Asimakopulos (1983) argues that the theoretical positions taken by both Kalecki and Keynes onfinanring investment entail certain weaknesses in that: They both underestimated the time required beforethe initial liquidity position of the banking system could be restored after banks increased their loans tofinance an increase in investme nt . . . Th ere was also insufficient attention given to the requirem ent forlong-term finance (or at least confidence about its availability) in order for firms to proceed with theirinves tme nt plant' (p. 23 2) . Th e respo nse to this charge has been substantially supportive of Keynes andKalecki: see, for example, Kregel (19 84 -19 86 ), Davidson (19 86, 1992), and Shapiro (199 2), amongst others.



Post-Keynesian econo m ics: towards coherence 125

the creation of appropriate institutions and conventions to help deal with uncertainty, issubject to periodic, unpredictable and discrete shifts. These institutions and conventions,however, generate much more stability than would be offered by the continuous andsimultaneous market-clearing mechanism. An important implication of this analysis isthat Keynes's unemployment 'equilibrium' is not based on imperfections in the operationof the price mechanism, but on 'the imperfection of agents' knowledge causinguncertainty over the propositions determining the return of investment projects' (Kregel,1987, p. 531).

An interesting development of the views just summarised, but relying more onKalecki's investment theory, is Steindl's (1952, 1979) 'maturity thesis'. Steindl'sargument is that increases in concentration lead to higher markups and, with profitsdetermined by past investment decisions, a slow down in capacity utilisation ensueswhich increases excess capacity. This process affects investment decisions adversely sincefirms are fearful of increasing excess capacity, with the economy having the tendency to

stagnate. The growth of concentration, therefore, reduces the incentive to invest andexacerbates stagnation tendencies. Hence, the degree of concentration has far reachingimplications for macroeconomic performance. One further implication is that Steindlprovides in this way an analysis which endogenises concentration.

Investment in its turn is the most important variable indistribution theory. Post-Keynesian economics dem onstrates that markets d istribute income according to relativepower (Nell, 1980). The output produced by one class of society (the wage earners) isplanned, directed and managed by another class of society that does not participatedirectly in production (the recipients of residual income profit). In this power relation-ship, capital's objectives are in conflict with labour's objectives so that 'conflict' is at theheart of the analysis. Marginal propensities to consume out ofwages and profits differ,hence on a steady-state growth path the shares of profits and wages are related to themarginal propensities to consume and to the ratio of investment to income. Pasinetti(1974, p. 113) has shown that control over the rate of investment implies control overdistribution and the rate of profit.

The 'conflict' element of post-Keynesian economics is highlighted in thewagedetermination dieory where bargaining in the labour market is the kernel ofthis analysis.Workers have aspirations as well as economic and political power which are described interms of a 'target real wage'. Deviations of actual real wages from die desired level affectthe level of money wage dem ands, thereby causing an upward pressure on money wagesif the desired level is greater than die actual. Similarly, there would be a downward

pressure on money wages when the real wage exceeds the target real wage. Expectationsof price inflation over die contract period, the rate of change of unemployment seen asa proxy for the speed of expansion or contraction of 'the reserve army of unem ployed',and the position of workers in the income distribution relative to certain reference groupsare further variables that are thought to be important determinants of nominal wages(Arestis, 1992; Arestis and Skott, 1993; Marglin, 1984B; Rowthom, 1977; Harcourt,1965). Wages, therefore, emerge as the result of a 'conflict' between employers andemployees. Wage determination is crucially influenced not just by economics bu t also bya host of odier factors, including political, historical, sociological and psychologicalforces, in which case it is conceivable diat higher real wages are accompanied byadditional dem and for labour, not less (as in orthodox analysis). The markup hypothesisis invoked, so that real wages are determined in both labour and product markets(Kalecki, 1969; Robinson, 1977).



126 P. Arestis

The rate of wage inflation relative to productivity along with that of prices of importsand raw materials are taken to be the most vital determinants of price inflation. There is,thus, a mutually reinforcing process of price changes and wage changes built into theeconomic system. Hence, if workers succeed in pushing up money wages, these wage

rises will be passed on in higher prices. Faced with firms operating in an oligopolistic andmonopolistic environment, labour will find it difficult to raise its wage share at theexpense of profits. The result ofthe struggle will therefore be an inexorable tendency ofthe price level to rise. This is not to say that wage pressure is thecause of inflation per se .Wage and price increases are inextricably linked and are merely symptoms of anunderlying structural problem, so that the theory of inflation alluded to by post-Keynesians belongs squarely to the 'conflict theory' framework.

Investment and distribution are fundamental determinants of growth and cycles inpost-Keynesian economics, and it is to these aspects that we turn our attention next.

Growth and cyclical dynamicsGrowth dynamics emanates from the concern of post-Keynesian economics with aneconomy that is growing over time in the context of history. The formula for the rate ofgrowth of national income, G=s/v, where G is the rate of growth, s is the averagepropensity to save andv the capital to output ratio, is the starting point. This expression,which extends Keynes's economic analysis inThe General Theory to the case of a 'growingeconomy', is modified to take account of the contention that the average propensity tosave is affected by income distribution whereby the marginal propensities to save out ofprofits and wages differ. The proposition then follows that steady-state growth at fullemployment is crucially linked to distribution and capital accumulation. The ratio ofprofits to income ensures that the average propensity to save (itself a function of the

marginal propensity to save out of capitalist income and the share of profits) is such thatequality between the natural and warranted growth rates are brought into equality. It isthought that changes in the income distribution can produce and maintain fullemployment in the long run.

Robinson (1956, 1962) and Kalecki (1971) believed that long-run steady-statesituations had no independent existence except as imaginary states of affairs which couldonly be utilised as convenient theoretical benchmarks. In this view, it is not so muchdistribution that determines growth but investment and technical progress, especiallyinvestment which is the 'engine of growth'. Rowthorn (1981) has investment based onprofitability generating savings in the form of retained profits which finance investment;the process of profit-creation can only be understood by reference to pricing, so thatgrowth, distribution, capital accumulation and pricing are all linked in this model. Amore recent study within the spirit of this analysis which incorporates the case of openeconomies is Bhaduri and Marglin (1990) (see also Marglin, 1984A; and Marglin andBhaduri, 1991). This model demonstrates that under certain circumstances wage-ledgrowth rather than profit-led growth policies stand a better chance of moving theeconomy to full-employment, along with a fairer distribution of income.

The treatment of technical progress in post-Keynesian growth economics followsRobinson (1956) who argues that it is entirely endogenous. Technical change is seen asthe result of entrepreneurial initiative and drive to search for cheaper and more efficientmethods of production. But there is a two-way relationship here. On the one hand,

technical change stimulatesnet investment. On the other hand, the implementation oftechnical change requires gross investment so that the new capital equipment would




facilitate the application of new technology. Consequently, faster technical change canonly come about if a higher rate of investment expenditure, and thus growth, isforthcoming. Kaldor (1960, 1966) also argues that technical progress is both the causeand the result of economic growth. This analysis is based on the notion of circularcausation so that a faster rate of growth leads to a higher rate of technical progress whichin turn influences the rate of growth.

The theory of'circular and cumulative causation' (Myrdal, 1939, 1957) is essentiallybased on the dynamic interplay between investment and productivity growth and islinked to the discussion of inequalities and regional disparities in economic developmentIn this view, industrial development is explained by endogenous factors in a dynamiccontext rather than by the exogenous 'resource endowment' (K aldor, 1970, p . 343) .Recent developments in growth theory (Romer, 1986; Baldwin, 1989) emphasise therole of economies of scale in the growth process. The basic assumption made is that ofincreasing returns which are largely caused by technological progress. There are certain

implications of this assumption in terms of steady state properties: when the outputelasticity of capital is unity, exogenous changes in the output/capital ratio will have animpact on the growth rate, and the savings ratio will influence the growth rate. Savings,therefore, assume an important role in the growth process, though there is still thequestion of whether economies of scale are important at the economy-wide level(Baldwin, 1989, p. 257) .

Post-Keynesian business cycle theory starts from the fundamental assumption thatcycles are inherent in capitalist economies. Business cycles are thus depicted asendogenous phenomena caused by the normal functioning of the capitalist economicsystem (Kaldor, 1940; Kalecki, 1971, ch.ll; Goodwin, 1967), with exogenous shocks,oil price changes for example, viewed as accentuating an endogenously embeddedinstability. This instability arises from the motive of producers and financial investorsalike to accumulate wealth for its own sake. It is, merefore, not surprising to find thatinvestment, expectations and distribution are at the heart of post-Keynesian businesscycle theory.

Kaldor's (1940) model has been influential in post-Keynesian business cycle analysis.This model depends on the intersection of non-linear savings and investment relation-ships and on dieir shifts caused by changes in capital stock. These create both stable andunstable 'equilibria' which are responsible for the cyclical movem ents. The m odel suffersfrom its neglect of the labour market. As it is built around the product market only, thebargaining position and strength of labour are ignored. This is an aspect which is

predominant in Goodwin's (1967) theory of business cycles which relies on thedistributive shares of capital and labour to explain the economy's cyclical behaviour.Class struggle over distribution is confined exclusively to the labour market. There areno aggregate demand problems to worry about, since investment always adjustsautomatically to clear the product market. Both investment and output are passive andaccommodating variables. Control over production and investment decisions, which isapowerful weapon in the hands of capital in the class struggle, is entirely absent. Morerecently, however, Goodwin and Punzo (1987) have integrated effective demand into themodel and Skott (1989) extends Goodwin's model by incorporating K eynesian elements.The underlying cyclical mechanism of this model implies significant differences fromGoodwin's original.

By contrast, Kalecki's (1971) model of business cycles is based on the notion thatit is the cyclical behaviour of investment expenditures which is the major cause of




There are a num ber of constraints associated with these economic policy prescriptions.There is the operation of transnational corporations and international financial centreswhich can impose considerable constraints on the implementation of the type ofeconomic policies post-Keynesian economic analysis alludes to (the UK post-World War

II experience is an excellent example in this context). It is, then, very important forgovernments to establish control over the operations of transnational and financ ialcentres. Financial market deregulation and the IMF-style stabilisation policies haveproduced an environment where what matters is deflationary policies to keep the'confidence' of financ ial markets. Inevitably, high levels of unemployment and undesir-able distributional effects especially in the LDCs (Arestis and Demetriades, 1993), havematerialised without any signs of financial deregulation, or of IMF policies beingremotely successful in terms of producing sustainable high growth rates. Policy-makersshould attempt to affect directly the sphere of regulation of international capital as wellas trade flows. Such endeavour could also alleviate the balance-of-payments constraint(Christodoulakis and Godley, 1987). Keynes (1980) proposed permanent capitalcontrols, both inward and outward, to deal with situations when the internationalfinanciers become untamable. He also insisted that the entire financial system shouldcome under perm anent control, and propounded the idea of planning to encapsulate theentire international system (see also, Hicks, 1985). In this sense, international economicpolicy coordination, especially among the major industrialised countries, becomes ofparamount importance.

Another potentially serious constraint on this type of economic policy is its heavyreliance on social co-operation and social consensus between labour, industry and thestate. Such a consensus may be difficult to achieve in view of recent labour marketderegulation. There are examples of countries where attempts at consensus have not

always been successful (for example the UK); equally, there are economies that havebeen more fortunate with such endeavours (Austria and the Scandinavian countries aregood examples in this context). The experience and institutional arrangements of thelatter countries are worth serious consideration for they provide some evidence thatconsensus is, potentially at least, feasible. Additional evidence suggests that increasedworker participation in decision-making is an important determinant of increases inproductivity. So that firms that adopt 'workers participation' as a conscious policy,experience better performance (in terms of sales, growth, profitability as well as overalleffectiveness) than similar firms that do not pursue these policies (Hodgson, 1984).

Finally, intemationalisation and globalisation of both financial and industrial capitalhave imposed on individual countries further constraints in the implementation ofeconomic policies. These kind of developments, however, indicate that economicpolicies should have a better chance of success when they are explicitly and firm ly'internationalist' (Radice, 1989). A very good example in this regard is the proposedcloser collaboration and co-ordination of macroeconomic policies amongst the membercountries of the European Union.

Summary and conclusions

This paperhas attempted to identify the main methodological and theoretical ingredientsof post-Keynesian economics. I t has tried to show that this way of thinking about how

the economy works draws on a body of method and theory which represents a consistentway of analysing economic phenomena. Indeed, we should like to end this paper by



130 P. Arestis

suggesting that post-Keyn esian economics has reacheda stage in its development whichentitles it to lay claims to internal coherence (see, also, Arestis, 1992; Botris, 1986).

Th ere are, however, areas that either remain underdevelop edor need to be developed.Consumer choiceand human behaviour in general is perhaps the mo st glaring example.

Recent contributions by Eichner (1991) and Lavoie (1994), which have identifiedanumbe r of principles upon which relevant workcan be built, are a significant step inthe right direction. Further researchis urgently needed on how aggregate supplyshould be modelled if profit maximisation is rejected (see, however, Eichner, 1976,1991). International economics and the economics of developing countries shouldbement ioned in this context, althoughit must be said that in these areas some progresshasbeen made: Arestis and Milberg (1993/4) and Cowling and Sugden (1994) are goodexamples in the case of international economics,and Dutt (1990) in the case of theeconomics of developing countries.A related area where more research effortis neededis the international dimension of demand mana gem ent arising from No rth/Sou thinteraction affecting primary commodity prices, followingthe start made by Kalecki(1971) and Kaldor (1976) and continued by Thirlwall (1980)—see, also, Beckermanand Jenkinson, 1986. Somewhat surprising is the fact that, although post-Keynesianmonetary economics has been researched quite substantially, finance theory remainsconsiderably underdeveloped. Thereare pointers, however, to directions which mightfruitfully be followed (see, for example, Davidson, 1988B;and Findlay and Williams,1985 ). Also surprising isthe absence of developments within m onetary econom ics on therole of monetary versus fiscal policyin deregulated international financial markets,anarea where research needsto be undertaken urgently.

These are a few examples which highlightthe point that there are still many areaswhich pose major problemsfor post-Keynesian theory. But the considerable progress

that has been made in recent years amply justifies the claim that post-Keynesianeconomics has progressed beyond merely offeringa critique of mainstream economicsand , as this contribution has endeavoured to demonstrate , has now reached the stage ofconstituting a positive approach characterisedby internal coherence.

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